After keeping certain percentage of the deposits (as part of CRR/SLR, say '10%) with the banks, the *rest is given out as credit/loan. Now this *rest won't actually be simple summed up money . It involves thing called money multiplier, inclusive of '10%. Sounds complicated? If so, just ignore it for now and get to understand that bank needs money to do business. And bank's main source of income is mainly interests earned through loans.

Now if those loans turn out as NPAs (Non Performing Assets), the banks would be hard pressed to carry on their daily functions, let alone think about profits. Any country would not let this happen, else entire financial system would collapse.

That's when Govt/Central Banks intervene. Bank are pumped with extra money to carry on their jobs.

How fund? The govt does the funding by two routes:

1. Budgetary allocation. 2. Market funding.

Now, recapitalization bond basically is about market funding. Ownership interests of banks (read NPAs, mostly) are out in the market for sale. People buy it. Money comes into the system. That's your recapitalization bond in very brief.

why it was in news? Government announced that it will recapitalise public sector banks to the tune of 2.11 lakh crore. Out of this 1.35 is Recapitalization bond, 18,139 crore through capital infusion from budget and 5800 crores through psb stake sales. Now why government need to recapitalize public sector banks? Why government opted for recapitalization bond and not capital infusion through budgetary allocation? Lets understand the whole concept in a dramatic way,

Lets assume "ForumIAS" is one of the public sector bank and Mr.Arun Jaitley wishes to recapitalize us. We have Rs.100 as our capital and following is our balance sheet,

1)Rs.60 is given as loans to various sectors (Ideally a banks deposit to credit ratio will be around 69%) out of which Rs.10 given as loan to Mr.X and Y and was not paid (So Non Performing Asset).2)Rs.22 is invested in bonds and securities (to meet SLR requirements)3)Rs.4 with RBI as CRR4)We have unused Rs.14 with us. we may give it as loan or invest.But it is a burden till it is used as we have to pay interest for our depositors. Its like taking personal loan and not using the money.

Following are the problems faced by us,We do not have enough capital to meet BASEL 3 standards (what is basel 3, lets learn later)Non-performing asset seems to be a problem.

Now government wants to give us Rs.20 out of which Rs.10 will be recapitalization bond, now we are so happy as some our problems related to capital will be solved. Now Mr. Jaitley calls us to take the Rs.10 bond. This is what we do,1) We use the fund with us to buy the Rs.10 bond. We are ok with this, because the bonds belong to government and we dont have to worry, because it yields us regular interest and may not turn NPA as it happened with Mr. X and Y. In fact a good business.Our burden of not utlizing the money is also solved and keeping it idle is also solved.2) Mr.Jaitley has the fund paid by us to subscribe the bond - he will invest back in us and buy our shares (read it as equity). Now our 100 became 110. So our additional capital increased, helping us marginally in reaching BASEL 3 norms.3) If you notice, we do not have any excess funds, after all we used almost everything. But we need Rs.10 to give loan to Infosys which seems to be good business. So we sell the bond with us in market and raise capital (cash).

This is how recapitalisation bond bring money into the banking system

What is the advantage?Government did not give the money from the budget. It means tax payers money is not spent here. So no need to worry about increasing Tax revenue.As it did not borrow money to fund, fiscal deficit will not increase.Government dont have to worry about paying the entire 1.35 lakh crore. Because in budget it going to pay just the interest portion. So gov has funded a big money with little impact in its purse.

Note: Some points mentioned in previous answers are technically wrong.RBI is not going to issue bond, it might be issued by a holding company which to the best of my knowledge is yet to be finalized. Equity (mentioned as ownership) has nothing to with NPA. People are not going to buy NPA. Option is given to banks to sell the bond and the same can be used for writing off NPA.

@Wakaao tell me am I correct? Govt don't have enough money to directly inject into banks.So RBI issue bond on behalf of govt, money obtained from that bonds given to banks.

Yes, you are correct. :-)

No this is wrong understanding.

Imagine you are a moneylender (bank). Your business will be borrowing money at cheaper rate and then lending at higher rate. But if that is all the money u have, that is, only the borrowed money, then you are in trouble as when the lent money do not come back (that is someone default on your credit) then how will you pay back your own creditor. So the bottom line is that you need to have some money of your own, which you are going to put in the business. This own money will show how resilient you are. Actually this is what basel norms are for as well.

So what is recapitalisation? Recapitalisation is owner putting his own money into the business. So government as the owner is putting more money into its business that is banks.

How bonds help recapitalisation? Either the government put money in cash or write a piece of paper (bond) which is worth a certain amount and say that this money can be used by the bank whenever it is needed is one and same thing.

Moral of the story? Need to put more money in the bank not in terms of deposits by people but in terms of money which goes into the ownership. That is own money.

@Wakaao tell me am I correct? Govt don't have enough money to directly inject into banks.So RBI issue bond on behalf of govt, money obtained from that bonds given to banks.

Yes, you are correct. :-)

No this is wrong understanding.

Imagine you are a moneylender (bank). Your business will be borrowing money at cheaper rate and then lending at higher rate. But if that is all the money u have, that is, only the borrowed money, then you are in trouble as when the lent money do not come back (that is someone default on your credit) then how will you pay back your own creditor. So the bottom line is that you need to have some money of your own, which you are going to put in the business. This own money will show how resilient you are. Actually this is what basel norms are for as well.

So what is recapitalisation? Recapitalisation is owner putting his own money into the business. So government as the owner is putting more money into its business that is banks.

How bonds help recapitalisation? Either the government put money in cash or write a piece of paper (bond) which is worth a certain amount and say that this money can be used by the bank whenever it is needed is one and same thing.

Moral of the story? Need to put more money in the bank not in terms of deposits by people but in terms of money which goes into the ownership. That is own money.

I find @Lone Wolf's reasoning fairly correct given the relationship between Central Bank and commercial banks vis a vis Govt. Also, let's not forget that there's no entity yet to deal with the recapitalization bonds.

Also, just issuing securities is not a healthy proposition . One cannot just say that it won't affect fiscal deficit. How else the govt would finance the interests that would run in crores?

I find @Lone Wolf's reasoning fairly correct given the relationship between Central Bank and commercial banks vis a vis Govt. Also, let's not forget that there's no entity yet to deal with the recapitalization bonds.

Also, just issuing securities is not a healthy proposition . One cannot just say that it won't affect fiscal deficit. How else the govt would finance the interests that would run in crores?

fiscal deficit will be taken care off by issuing bonds in a staggered fashion that is not all at one time and second the govt will make the bonds redeemable or payable at a later date,,,, this will ensure that fiscal effects are reduced

why it was in news? Government announced that it will recapitalise public sector banks to the tune of 2.11 lakh crore. Out of this 1.35 is Recapitalization bond, 18,139 crore through capital infusion from budget and 5800 crores through psb stake sales. Now why government need to recapitalize public sector banks? Why government opted for recapitalization bond and not capital infusion through budgetary allocation? Lets understand the whole concept in a dramatic way,

Lets assume "ForumIAS" is one of the public sector bank and Mr.Arun Jaitley wishes to recapitalize us. We have Rs.100 as our capital and following is our balance sheet,

1)Rs.60 is given as loans to various sectors (Ideally a banks deposit to credit ratio will be around 69%) out of which Rs.10 given as loan to Mr.X and Y and was not paid (So Non Performing Asset).2)Rs.22 is invested in bonds and securities (to meet SLR requirements)3)Rs.4 with RBI as CRR4)We have unused Rs.14 with us. we may give it as loan or invest.But it is a burden till it is used as we have to pay interest for our depositors. Its like taking personal loan and not using the money.

Following are the problems faced by us,We do not have enough capital to meet BASEL 3 standards (what is basel 3, lets learn later)Non-performing asset seems to be a problem.

Now government wants to give us Rs.20 out of which Rs.10 will be recapitalization bond, now we are so happy as some our problems related to capital will be solved. Now Mr. Jaitley calls us to take the Rs.10 bond. This is what we do,1) We use the fund with us to buy the Rs.10 bond. We are ok with this, because the bonds belong to government and we dont have to worry, because it yields us regular interest and may not turn NPA as it happened with Mr. X and Y. In fact a good business.Our burden of not utlizing the money is also solved and keeping it idle is also solved.2) Mr.Jaitley has the fund paid by us to subscribe the bond - he will invest back in us and buy our shares (read it as equity). Now our 100 became 110. So our additional capital increased, helping us marginally in reaching BASEL 3 norms.3) If you notice, we do not have any excess funds, after all we used almost everything. But we need Rs.10 to give loan to Infosys which seems to be good business. So we sell the bond with us in market and raise capital (cash).

This is how recapitalisation bond bring money into the banking system

What is the advantage?Government did not give the money from the budget. It means tax payers money is not spent here. So no need to worry about increasing Tax revenue.As it did not borrow money to fund, fiscal deficit will not increase.Government dont have to worry about paying the entire 1.35 lakh crore. Because in budget it going to pay just the interest portion. So gov has funded a big money with little impact in its purse.

Note: Some points mentioned in previous answers are technically wrong.RBI is not going to issue bond, it might be issued by a holding company which to the best of my knowledge is yet to be finalized. Equity (mentioned as ownership) has nothing to with NPA. People are not going to buy NPA. Option is given to banks to sell the bond and the same can be used for writing off NPA.

+100

This is the correct answer. The other answers above have got the technicalities all wrong.

Even the internet is full of wrong articles related to recapitalization.

why it was in news? Government announced that it will recapitalise public sector banks to the tune of 2.11 lakh crore. Out of this 1.35 is Recapitalization bond, 18,139 crore through capital infusion from budget and 5800 crores through psb stake sales. Now why government need to recapitalize public sector banks? Why government opted for recapitalization bond and not capital infusion through budgetary allocation? Lets understand the whole concept in a dramatic way,

Lets assume "ForumIAS" is one of the public sector bank and Mr.Arun Jaitley wishes to recapitalize us. We have Rs.100 as our capital and following is our balance sheet,

1)Rs.60 is given as loans to various sectors (Ideally a banks deposit to credit ratio will be around 69%) out of which Rs.10 given as loan to Mr.X and Y and was not paid (So Non Performing Asset).2)Rs.22 is invested in bonds and securities (to meet SLR requirements)3)Rs.4 with RBI as CRR4)We have unused Rs.14 with us. we may give it as loan or invest.But it is a burden till it is used as we have to pay interest for our depositors. Its like taking personal loan and not using the money.

Following are the problems faced by us,We do not have enough capital to meet BASEL 3 standards (what is basel 3, lets learn later)Non-performing asset seems to be a problem.

Now government wants to give us Rs.20 out of which Rs.10 will be recapitalization bond, now we are so happy as some our problems related to capital will be solved. Now Mr. Jaitley calls us to take the Rs.10 bond. This is what we do,1) We use the fund with us to buy the Rs.10 bond. We are ok with this, because the bonds belong to government and we dont have to worry, because it yields us regular interest and may not turn NPA as it happened with Mr. X and Y. In fact a good business.Our burden of not utlizing the money is also solved and keeping it idle is also solved.2) Mr.Jaitley has the fund paid by us to subscribe the bond - he will invest back in us and buy our shares (read it as equity). Now our 100 became 110. So our additional capital increased, helping us marginally in reaching BASEL 3 norms.3) If you notice, we do not have any excess funds, after all we used almost everything. But we need Rs.10 to give loan to Infosys which seems to be good business. So we sell the bond with us in market and raise capital (cash).

This is how recapitalisation bond bring money into the banking system

What is the advantage?Government did not give the money from the budget. It means tax payers money is not spent here. So no need to worry about increasing Tax revenue.As it did not borrow money to fund, fiscal deficit will not increase.Government dont have to worry about paying the entire 1.35 lakh crore. Because in budget it going to pay just the interest portion. So gov has funded a big money with little impact in its purse.

Note: Some points mentioned in previous answers are technically wrong.RBI is not going to issue bond, it might be issued by a holding company which to the best of my knowledge is yet to be finalized. Equity (mentioned as ownership) has nothing to with NPA. People are not going to buy NPA. Option is given to banks to sell the bond and the same can be used for writing off NPA.

+100

This is the correct answer. The other answers above have got the technicalities all wrong.

Even the internet is full of wrong articles related to recapitalization.

yup explained in the most comprehensive and corrct way....recapitalization is essentially an accounting exercise with govt paying nothing except the interest on bonds.

@Arsenal752@Rodion Raskolnikov yeah the idea that govt gives the bond to bank for cash and then use that cash for buying bank shares is the right one,,, i ommitted it to make things simpler but realise that analysis can go wrong in how the bonds affect fiscal deficit in absence of above mechanism

why it was in news? Government announced that it will recapitalise public sector banks to the tune of 2.11 lakh crore. Out of this 1.35 is Recapitalization bond, 18,139 crore through capital infusion from budget and 5800 crores through psb stake sales. Now why government need to recapitalize public sector banks? Why government opted for recapitalization bond and not capital infusion through budgetary allocation? Lets understand the whole concept in a dramatic way,

Lets assume "ForumIAS" is one of the public sector bank and Mr.Arun Jaitley wishes to recapitalize us. We have Rs.100 as our capital and following is our balance sheet,

1)Rs.60 is given as loans to various sectors (Ideally a banks deposit to credit ratio will be around 69%) out of which Rs.10 given as loan to Mr.X and Y and was not paid (So Non Performing Asset).2)Rs.22 is invested in bonds and securities (to meet SLR requirements)3)Rs.4 with RBI as CRR4)We have unused Rs.14 with us. we may give it as loan or invest.But it is a burden till it is used as we have to pay interest for our depositors. Its like taking personal loan and not using the money.

Following are the problems faced by us,We do not have enough capital to meet BASEL 3 standards (what is basel 3, lets learn later)Non-performing asset seems to be a problem.

Now government wants to give us Rs.20 out of which Rs.10 will be recapitalization bond, now we are so happy as some our problems related to capital will be solved. Now Mr. Jaitley calls us to take the Rs.10 bond. This is what we do,1) We use the fund with us to buy the Rs.10 bond. We are ok with this, because the bonds belong to government and we dont have to worry, because it yields us regular interest and may not turn NPA as it happened with Mr. X and Y. In fact a good business.Our burden of not utlizing the money is also solved and keeping it idle is also solved.2) Mr.Jaitley has the fund paid by us to subscribe the bond - he will invest back in us and buy our shares (read it as equity). Now our 100 became 110. So our additional capital increased, helping us marginally in reaching BASEL 3 norms.3) If you notice, we do not have any excess funds, after all we used almost everything. But we need Rs.10 to give loan to Infosys which seems to be good business. So we sell the bond with us in market and raise capital (cash).

This is how recapitalisation bond bring money into the banking system

What is the advantage?Government did not give the money from the budget. It means tax payers money is not spent here. So no need to worry about increasing Tax revenue.As it did not borrow money to fund, fiscal deficit will not increase.Government dont have to worry about paying the entire 1.35 lakh crore. Because in budget it going to pay just the interest portion. So gov has funded a big money with little impact in its purse.

Note: Some points mentioned in previous answers are technically wrong.RBI is not going to issue bond, it might be issued by a holding company which to the best of my knowledge is yet to be finalized. Equity (mentioned as ownership) has nothing to with NPA. People are not going to buy NPA. Option is given to banks to sell the bond and the same can be used for writing off NPA.

Spot On.Imp point explained above Recap Bonds will NOT affect Fiscal Deficit.New loans given through bonds to Gobt will NOT turn bad loans --> No future NPA on these loansGovt may use such loans to buy shares of the banks - Govt ownership will increase.Help in reaching closer to BASEL 3 norms

Uncertain things as of now: No mechanism has beeen explained yet how it will work- so DONOT know who will issue the bonds.Role of RBI is uncertain

why it was in news? Government announced that it will recapitalise public sector banks to the tune of 2.11 lakh crore. Out of this 1.35 is Recapitalization bond, 18,139 crore through capital infusion from budget and 5800 crores through psb stake sales. Now why government need to recapitalize public sector banks? Why government opted for recapitalization bond and not capital infusion through budgetary allocation? Lets understand the whole concept in a dramatic way,

Lets assume "ForumIAS" is one of the public sector bank and Mr.Arun Jaitley wishes to recapitalize us. We have Rs.100 as our capital and following is our balance sheet,

1)Rs.60 is given as loans to various sectors (Ideally a banks deposit to credit ratio will be around 69%) out of which Rs.10 given as loan to Mr.X and Y and was not paid (So Non Performing Asset).2)Rs.22 is invested in bonds and securities (to meet SLR requirements)3)Rs.4 with RBI as CRR4)We have unused Rs.14 with us. we may give it as loan or invest.But it is a burden till it is used as we have to pay interest for our depositors. Its like taking personal loan and not using the money.

Following are the problems faced by us,We do not have enough capital to meet BASEL 3 standards (what is basel 3, lets learn later)Non-performing asset seems to be a problem.

Now government wants to give us Rs.20 out of which Rs.10 will be recapitalization bond, now we are so happy as some our problems related to capital will be solved. Now Mr. Jaitley calls us to take the Rs.10 bond. This is what we do,1) We use the fund with us to buy the Rs.10 bond. We are ok with this, because the bonds belong to government and we dont have to worry, because it yields us regular interest and may not turn NPA as it happened with Mr. X and Y. In fact a good business.Our burden of not utlizing the money is also solved and keeping it idle is also solved.2) Mr.Jaitley has the fund paid by us to subscribe the bond - he will invest back in us and buy our shares (read it as equity). Now our 100 became 110. So our additional capital increased, helping us marginally in reaching BASEL 3 norms.3) If you notice, we do not have any excess funds, after all we used almost everything. But we need Rs.10 to give loan to Infosys which seems to be good business. So we sell the bond with us in market and raise capital (cash).

This is how recapitalisation bond bring money into the banking system

What is the advantage?Government did not give the money from the budget. It means tax payers money is not spent here. So no need to worry about increasing Tax revenue.As it did not borrow money to fund, fiscal deficit will not increase.Government dont have to worry about paying the entire 1.35 lakh crore. Because in budget it going to pay just the interest portion. So gov has funded a big money with little impact in its purse.

Note: Some points mentioned in previous answers are technically wrong.RBI is not going to issue bond, it might be issued by a holding company which to the best of my knowledge is yet to be finalized. Equity (mentioned as ownership) has nothing to with NPA. People are not going to buy NPA. Option is given to banks to sell the bond and the same can be used for writing off NPA.

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